The Tangled Web

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Before we begin, let us state clearly that this is speculation by Karl Denninger at The Market Ticker. Examining the various stakeholders' interests in General Motors, Denninger has come up with a scenario that supposes GM's bondholders might actually want the automaker to file for bankruptcy.

The bondholders appear to be the biggest obstacle to restructuring. They're not allowing GM to reach its government-mandated target for debt reduction because they would lose much of their investment in the process. According to Denninger, however, the biggest and most savvy of those bondholders could get 100% of their investment back if GM files for bankruptcy. Those bondholders would have had their bonds backed by credit default swaps (CDS), which Denninger supposes would have been written in large part by insurance giant AIG. If that's the case, then we the taxpayers are on the hook to repay 100% of those bonds because the government has agreed to fulfill AIG's CDS collateral obligations.

Thus, these particular bondholders would have no reason to help GM stay afloat by reducing its debt obligations. If GM goes under, they would just wait for checks from the government to be made whole again. Denninger goes on to say that in such a scenario, these bondholders could make even more than 100% of their investment back because the government backing takes place "even if the bonds have a recovery in bankruptcy." The only way to stop this would be for the government to decline to back any more AIG obligations, which could then bankrupt the "too big to fail" AIG depending on its ultimate exposure, but would save GM. Decisions, decisions...

This theory relies on AIG being in the middle of things, yet it wouldn't be outrageous to think that the biggest and smartest institutional bondholders went to the best known CDS paper writer for protection. As if that weren't enough, Denninger suggests that government-backed warranty work could become "a monstrous inducement" for dealers to bilk the government, a version of Medicare fraud for the car industry. The next 57 days look to be as exciting as they will eventually be costly.

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It isn't really true that if the US stopped backing the AIG obligations this "would save GM". Even without this backing the bond holders might be wise to keep what they have. My understanding is that in bankruptcy the bonds will likely get paid out at some % whereas the shares (which is what the bondholders will exchange their bonds for) will not.

Not only that, but if this was the only holdup then wouldn't the US government just buy back all the bonds right now? It sounds like they are apparently on the hook regardless.